India gets single-market religion amid Brexit trigger

Currently, selling across the borders of India’s 29 states means paying a central sales levy, which can’t be set off against tax paid on raw materials procured from within a company’s home jurisdiction. Photo: Priyanka Parashar/Mint

Singapore: Just as Britain’s prime minister began proceedings to exit the European Union, lawmakers in India approved the creation of an economic zone that’s been 17 years in the making.

A nationwide goods and services tax (GST) would, as early as 1 July, change the way your hotel bill in Mumbai reads. Mine, from a business trip earlier this month, had five different taxes totaling 19% levied on just the room.

A GST would subsume many federal and state taxes. For cinema operator PVR Ltd, being able to exit the tyranny of a 27% “entertainment tax” could mean a 2.5 to 3 percentage point boost to the company’s operating margin as it claims credit on taxes embedded in payments to vendors.

But the far bigger change, the one India Inc. is awaiting with anticipation and some apprehension, would be in interstate commerce.

Currently, selling across the borders of India’s 29 states means paying a central sales levy, which can’t be set off against tax paid on raw materials procured from within a company’s home jurisdiction. Those input credits will now be available under a GST.

This would do two things: One, given enough competition, most manufactured goods should get cheaper, stoking demand. Two, more companies will want to engage in interstate commerce, which they avoid at present by moving goods (without selling) to their own small, inefficient warehouses around the country.

Smaller Indian industrial firms—those with less than $1 billion in revenue—end up carrying more than five times their annual sales as inventory, compared with just 36% in China. A narrowing of this gap would boost profitability. More centralized warehousing would also boost demand for higher-tonnage trucks made by Tata Motors Ltd and Volvo AB.

But GST is also causing some anxiety. As Gadfly wrote last year, India is planning to employ Jeff Bezos of Amazon Inc. as its tax collector. All e-commerce marketplaces will deduct 2% from what they pay sellers of merchandise and deposit the money with the government. Sellers would then have to claim input-tax credits. The increase in working capital may be problematic for small businesses working on thin margins. Amazon India estimates that 180,000 jobs could be at risk.

Expect frenetic lobbying by businesses to get a good deal under the several slabs proposed in the GST code. Also, states’ reluctance to let go of lucrative local levies on alcohol and gasoline may mean taxes on average will be higher than they would otherwise have been. Similarly, keeping electricity outside of GST would mean no tax credits on solar panels or wind turbines. Power costs could go up.

China’s reform of indirect taxes in the 1990s played a large role in making that nation a manufacturing powerhouse. Still, with India’s stock markets near record highs, investors may be wary of placing optimistic bets on India’s GST.

Even after the new tax is adopted, it might take several years for the dust to settle. After all, unifying 1.25 billion people in a common market is one of the most ambitious economic changes India has attempted in its seven-decade-long existence as an independent nation.

Remarkably, that change is coming just as its former colonial master is retreating from a powerful union. Bloomberg